The emerging markets
The emerging markets are currently going through a challenging period. Since the start of the year, the MSCI Emerging Markets Index has lost 6% in local currency terms, contrasting with the industrialised countries, which have risen by just under 5%. The emerging markets’ underperformance is due to inflationary pressures that are starting to appear amid rising commodity prices - particularly food prices which represent on average around 30% of the CPI basket in this region. These pressures are forcing the region’s authorities to tighten monetary policy and raise key interest rates. Events in Tunisia and Egypt have also served to remind that the political risk remains high in certain countries. In an environment of short investment horizons, we are seeing a rotation towards the industrialised countries where monetary tightening is more of a far-off threat and where the latest macroeconomic data is on the whole better than expected. After the large capital inflows to the emerging markets in 2010, the past few weeks have seen significant outflows from these markets.
Before concluding that the recent absolute and relative performance of the emerging markets represents a strong investment opportunity, it is worth looking at this performance in a longer term context. Since 1990, a typical correction for the emerging markets was a 20% fall in share prices that usually lasted around six months. In this respect, the current correction of 6% over seven weeks could continue for a while. Such a scenario makes sense as long as the industrialised countries continue to benefit from a very favourable environment (better macroeconomic data and artificially low interest rates) and as long as investors are not convinced that the inflationary problem in the emerging markets is under control.
The current situation on the emerging markets and the good performance of the industrialised countries do not alter the economic and stock market reality, however. The growth differential between the emerging markets and the industrialised countries continues to favour an investment in the former. As a general rule, the emerging markets have much better fundamentals with, notably, a much lower level of debt. Their valuation is attractive in absolute terms with a price/earnings ratio of 11.8 for 2011 and in relative terms with a 15% discount to the industrialised countries despite a much higher profitability of emerging market companies. The fundamental attraction of the emerging markets is therefore not being called into question by the current correction.
The emerging markets are not a homogeneous class and it is important to differentiate between the various countries within this group. The chart below shows that three of the markets referred to as the BRIC (Brazil, Russia, India and China) countries have been underperforming the MSCI Emerging Markets index over one year, with a disappointing year on the stock markets in 2010 for Brazil and China in particular. We continue to give priority to the mature countries of Southeast Asia (which, for some, do not feature in the emerging market indices anymore).
>> Investment strategy 2011 - Read on the third part
